U.S. Real Estate Securities - January 2012 Review & Outlook
Cohen & Steers
February 21, 2012
We would like to share with you our review and outlook for the U.S. real estate securities market as of January 31, 2012. The FTSE NAREIT Equity REIT Index had a total return of +6.5% for the month, compared with a +4.5% return for the S&P 500 Index.
U.S. REITs got off to a solid start in 2012 as an improving economic outlook led to hopes of strengthening demand for commercial real estate. Aside from a few disappointing data points, the news was generally good across the board, including jobs growth, consumer confidence, industrial production and even upbeat statements from homebuilders. On the global front, positive developments in Europe significantly reduced the risk of a liquidity crisis, while data from China suggested the country was successfully navigating a soft landing to its economy.
Despite the signs of improvement, expectations for U.S. GDP growth in 2012 remained modest at around 2%, while the benign inflationary environment underscored the dampening effects of slowing global demand. During the month, the Federal Reserve announced that present conditions warranted keeping interest rates at near-zero levels through at least 2014 (out from its prior 2013 estimate). For real estate companies, this sent a strong signal that funding costs would remain low.
Cyclical and higher-risk companies outperformed
All property sectors advanced in January, led by a rebound in cyclically sensitive sectors such as hotels (+10.9% total return in the index) and industrial REITs (+10.4%). In contrast, defensive-oriented sectors underperformed, including self storage (+4.5%) and health care (+4.6%). Apartment REITs (+3.9%) had relatively modest gains amid concerns that improving sentiment in the single family housing market could lead to softer demand for rental properties.
Within the property sectors, companies with lower-quality assets and greater leverage generally outperformed, as risk factors associated with these companies diminished along with the better economic backdrop and low borrowing costs. For example, in the office sector (+7.9%), companies with assets in suburban (high cap-rate) markets did substantially better than their urban-focused (low cap-rate) peers. Likewise, among regional malls (+6.4%) and shopping centers (+8.8%), owners of mostly Class B properties such as Pennsylvania REIT, Inland Real Estate and Cedar Shopping Centers were among the top performers.
We are encouraged by the recent trend of U.S. economic data showing measured improvement, including steady employment gains. With funding costs likely to remain low and demand showing signs of strengthening, we believe U.S. real estate fundamentals will continue to gradually improve in 2012. Importantly, new supply remains scarce in most sectors, due in large part to banks’ continued reluctance to finance speculative development projects.
The positive trajectory is not without potential dangers, however. Economic growth remains at risk to global macro concerns, and our global investment team continues to closely monitor developments in Europe and China. We are also cognizant of risks related to political uncertainty in an election year, particularly with regard to the financial and health care industries, as well as the Washington, D.C. office market generally.
We have become more constructive regarding the growth potential of key office markets, including life sciences, technology and media, while finding increasing value in New York offices. To fund these investments, we have decreased our allocation to apartments following their strong run in 2011. However, we believe the market may be overestimating the risks to the sector’s growth, as apartment companies should continue to benefit from positive employment trends in the key 20-30 year-old demographic. We continue to favor prime retail owners, while staying cautious toward health care properties, suburban offices and secondary retail.
(c) Cohen & Steers